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Finance & Development, September 1973
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Economic Aid Through Debt Relief: Long-term foreign assistance, or help toward resolving a short-term liquidity problem?—a look at this sensitive issue with a table summarizing multilateral debt renegotiations 1956-73.

Author(s):
International Monetary Fund. External Relations Dept.
Published Date:
September 1973
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Thomas M. Klein

The main issue regarding debt relief in recent years has been whether it should be viewed as long-term foreign assistance or rather as help toward resolving a short-term liquidity problem. If the former, then debt relief can be thought of as providing—on terms approaching those available on new credits—resources for furthering a development program. If the latter, then debt relief can be regarded as exceptional temporary assistance to tide over a country until it is again in a position to resume payment of its international obligations. Whether debt relief is short or long-term help was one of the points discussed at the 1972 United Nations Conference on Trade and Development (UNCTAD III).

Multilateral debt relief

There have in recent years been a number of bilateral debt rearrangements in which a country has secured relief from one or more major creditor countries. However, our concern here is with rearrangements arrived at through multilateral agreements following conferences with representatives of major creditor countries.

Between 1956 and mid-1972, nine countries received debt relief through such multilateral agreements; seven of these required more than one debt rescheduling. Altogether 22 debt relief agreements have been reached. Each country found itself in a balance of payments crisis so severe that debt service payments could only be made at the expense of imports regarded as essential for maintaining minimum consumption, production and investment standards. The total amount of debt relief extended in this period—measuring it as the reduction of interest and principal payments in the years in which they fall due—amounted to $7 billion. (The terms and the amount of relief provided are set forth in Table 2.)

The circumstances which led to these multilateral debt reschedulings have some common characteristics. Most of the nine countries followed ambitious public investment programs which, in the absence of parallel programs to generate higher levels of domestic savings, were accompanied by substantial increases in the money supply and rising inflation. Exchange rates were not adjusted adequately or promptly enough to offset domestic cost increases, and this in turn reduced the profitability of production for export. In addition, several countries were faced by a decline in world market prices for their major exports: the coincidence of declining coffee prices with Brazil’s ambitious 1957-60 development program contributed to Brazil’s 1960-61 debt crises, and the sharp drop in copper prices during 1970-71 contributed significantly to Chile’s recent difficulties.

Argentina, Brazil, Chile, Peru, Turkey

The relatively economically advanced countries (Argentina, Brazil, Chile, Peru, and Turkey) had all received foreign private capital; but, when balance of payments difficulties threatened, an abrupt net outflow worsened the situation. To make up for low domestic savings and export earnings, these countries borrowed large sums abroad through suppliers’ credits and, for the Latin American countries, through medium-term commercial bank loans. Suppliers’ credit finance was readily available because exporters in developed countries could insure their credits against political and exchange risks through the government-financed export credit insurance corporations established in the early 1950s to stimulate capital goods exports.

Since these five countries relied on relatively short-term credits to fill the resource gap, the maturity structure of their external debt was very short at the time debt crises were reached: suppliers’ credits accounted for ⅓ to ⅔ of total public debt as contrasted with ⅙ for all developing countries. Interest and principal payments on medium-term and long-term debt due within two years, measured as a proportion of total debt outstanding, was 38 per cent for Argentina and Brazil and 56 per cent for Turkey (versus 20 per cent for all developing countries); and the proportion due within five years ranged between ⅔ and ⅘ for Argentina, Brazil, and Turkey (as compared with ½ for all developing countries). In addition, there were very significant arrears on short-term obligations. Public sector debt to foreign commercial banks was of a significant volume for Argentina, Brazil, Chile, and Peru. Each held talks with foreign commercial banks regarding rescheduling these obligations at the same time as negotiating multilateral debt relief agreements with foreign governments.

Ghana and Indonesia

Ghana’s 1966 debt crisis arose from its efforts after independence to reduce its reliance on cocoa exports through a massive investment program to provide infrastructure, to diversify agriculture and to enhance industrial production. About 30 per cent of capital formation between 1960-65 was financed by foreign borrowing which, except for the massive Volta River hydroelectric project and for an aluminum smelter, consisted of suppliers’ credits. Unfortunately, Ghana’s total output failed to increase, and by 1966 the debt service burden became intolerable. A new government instituted a policy of economic stabilization and sought foreign official assistance on concessional terms and debt relief on the pre-1966 suppliers’ credits.

The Indonesian rescheduling was necessitated by gross economic mismanagement in the latter years of the Sukarno regime. For example, annual budget deficits exceeded tax revenues by 50 per cent from 1963-65. Whereas Ghana at least completed its investment program with a larger capital stock—although an inappropriate one from the point of view of immediate growth—Indonesia’s capital stock declined as new capital formation was more than offset by deterioration of existing assets.

India

India’s debt problem is different. Its external debt consists largely of long-term loans from governments and multilateral agencies; suppliers’ credits and commercial bank loans are relatively unimportant. Economic development in India requires a continued net inflow of long-term foreign assistance to sustain an increasing volume of investment and imports. However, rapidly rising debt service obligations have been making it increasingly difficult to meet these requirements.

The conditions which caused India to seek debt relief follow, in part, from the pattern of aid extended in the past. In the first decade of independence, India relied only to a limited extent on foreign aid while sterling balances were drawn down. Following a balance of payments crisis in 1958, the World Bank organized an aid consortium for India, and for the next decade there were large and growing aid flows. Gross flows of $0.7 billion in financial year 1958/59 rose to $1.6 billion in 1965/66. But, in 1968/69, gross flows began to fall, declining to $1.1 billion in 1970/71. At the same time, debt service payments rose steadily so that out of the $1.1 billion gross inflow, the net transfer was only $0.5 billion. In 1967, the Indian Government requested debt relief through the aid consortium and in March 1968 it was agreed to extend debt relief of about $100 million per year over a 3-year period. This arrangement was extended for financial year 1971/72. The question of longer-term further debt relief is under discussion; meanwhile an agreement covering 1972/73 has been reached and relief for 1973/74 is being considered.

The 1968 debt relief agreement for India was unusual in that it was not associated with an immediate liquidity problem as were the previous multilateral debt agreements of other countries. Debt relief has served to increase the available amount of free foreign exchange. Project aid is restricted to the financing of the foreign exchange cost of individual projects, and program aid tied almost entirely to the purchase of goods from the donor country. India now has capital goods industries capable of producing equipment needed for investment; a substantial part of her imports of industrial material comes from developing countries and therefore must be financed with free foreign exchange. However, roughly one third of India’s convertible currency earnings are absorbed by debt service payments to western countries. Thus, the simplest technique for increasing free foreign exchange availability is to give debt relief.

Negotiations on debt relief

The organization of conferences on debt relief, other than those held by aid consortia, has appeared superficially as a series of ad hoc arrangements; but, in fact, a well-defined institutional arrangement has been established for considering debt relief requests. These requests are generally considered in meetings of representatives of the major western creditor countries, popularly known as the “Paris Club.” This has no formal organization but, because of the frequency of debt rescheduling requests, essentially the same representatives of the major creditor countries (France, Germany, Italy, Netherlands, United Kingdom, United States and, more recently, Japan) meet to deal with such requests. The Paris Club is, in fact if not by treaty, a functioning arrangement. Fundamentally, what holds the group together is a mutual desire among the creditor countries to negotiate as a group in order to establish a common response, bearing in mind the precedents already established and the possible consequences of the pending agreement on future requests for debt relief.

Debt relief conferences may be initiated by the debtor country government declaring a moratorium on debt service payments until the negotiations are completed. Under certain circumstances, there have been bilateral reschedulings; but normally, creditors prefer multilateral rescheduling to reassure themselves that each creditor’s debts are being rescheduled on the same terms.

Procedures for debt relief are influenced by the fact that most requests have been for relief on suppliers’ credits. Initially, debts were owed to the private sector of the creditor countries. However, under export credit insurance arrangements, when payment is in default the insurance company pays the insured portion of the claim (80-90 per cent of the contract value) and the debt is transfered from the private to the official sector of the creditor country. Because the creditor governments are chiefly negotiating what were originally commercial credits, they are accordingly cautious about applying soft terms. Furthermore, since Paris Club meetings establish a single set of terms applicable to all creditors there is a tendency to reach an agreement close to that which is permitted by the hardest major creditor.

A few debt relief arrangements have been organized by international agencies rather than through the Paris Club—for example, debt relief for India and Pakistan was arranged at consortia meetings chaired by the World Bank. Since aid consortia consist of countries and multilateral agencies concerned with providing economic assistance to developing nations, talk of debt relief evolved out of the discussion of providing a certain level of net transfer through foreign aid. In mid-1958, when Turkey faced a foreign exchange and debt servicing crisis a meeting of the countries of the Organization for European Economic Cooperation (later replaced by the Organization for Economic Cooperation and Development) the United States, and the International Monetary Fund was called at the initiative of the European Payments Union. Debt relief was given parallel with credits from the IMF and participating countries. In 1965, a second Turkish debt conference was organized by the Turkish Aid Consortium of the OECD.

Debt relief in operation

The techniques of debt relief are debt rescheduling or debt refinancing. The principle of debt rescheduling is that all or a portion of the debt service payments are postponed from the time they are due to an agreed future date. Debt refinancing entails the granting of a new loan by a government agency in the creditor country to the government of the debtor country. It makes available the currency of the creditor country at the time when payments are due on the debts eligible for refinancing; the individual debtor continues to make payments to the holder of the supplier credit in the exporting country and the refinancing loan makes the transfer possible. The economic effects of the two techniques are similar.

The period of time over which debt service is relieved—the “consolidation period”—has generally been three years or less. A major exception was the 1970 settlement with Indonesia which rescheduled over a 30-year period the entire outstanding Sukarno-era debt. However, if the creditors recognize that further debt relief may be needed, they insert a “good will” clause in the initial multilateral agreement, in which they agree to reopen the negotiations at a specified time. The principal rationale of such short-term agreements is that they give some assurance that the debtor countries will pursue appropriate stabilizing policies to reduce pressure on their balance of payments and thus provide sufficient foreign exchange to service the modified debt obligations.

Indeed such policy intentions by the debtor country have been an essential part of multilateral debt renegotiations, even though the obligations of the debtor are not set forth in detail in the agreement itself. In a number of instances conditions of securing debt relief included obtaining an IMF stand-by or undertaking to eliminate arrears in current payments and to exercise restraint in taking on new medium-term debt.

In many cases, contractual interest was “capitalized” and rescheduled in combination with the principal balance of the debts in question. Interest was also charged on the amounts of deferred payments including both capitalized contractual interest and the principal. Interest payments were normally payable during the grace period applicable to the deferred principal payments. This interest charge is referred to as “moratorium interest;” the rate to be charged was normally specified not in the multilateral debt agreements but in the subsequent bilateral negotiations. The multilateral agreements, however, usually established that this interest rate would be related to current market rates prevailing in each creditor country.

Table 1.Calculating the Grant Element of Debt ReliefExample: Argentine Agreement, October 1962
(in millions of US$)
A.Amount of debt relief (50 per cent of suppliers,

credits due in 1963 and 1964 were rescheduled):
19631964Total
A1Actual sums rescheduled62.9111.0173.9
A2Present value of debt relief (value in base year)162.9100.9163.8
B.Repayment made on debt relief:
19631964196519661967196819691970Total
B1Actual Amounts Principal8.726.034.834.834.834.8173.9
Moratorium interest (at 6% per annum)3.810.49.98.46.34.22.145.1
Total3.819.135.943.241.139.036.9219.0
B2Present value of total repayments (value of service stream in base year)*3.515.827.029.525.522.018.9142.2
C.Calculation of grant element:lineA2lineB2lineA2×100=163.8142.2163.8×100=13.2percent

Present value calculations made using 10 per cent discount rate, following the convention of the OECD’s Development Assistance Committee.

Present value calculations made using 10 per cent discount rate, following the convention of the OECD’s Development Assistance Committee.

Benefits of debt relief

The net benefit of debt relief may be gauged by calculating its grant element: the difference between the present value of the repayments stream and the present value of the debt relief expressed as a percentage of the present value of the debt relief. Table 1 shows the calculations involved in working out the benefits of debt relief—in this case, the 1962 rescheduling agreement with Argentina.

The multilateral debt relief agreements fall into three groups regarding their con-cessionality. Three agreements (Ghana 1970, Indonesia 1970, and India 1968) with grant elements of 48-61 per cent were very concessional. The agreements with Latin American countries (except the Argentina 1956 agreement) on the other hand, had very low grant elements, ranging from 5–15 per cent—which is roughly that for suppliers’ credits and foreign commercial bank term loans. In between these two groups were the moderately concessional agreements: the Argentina 1956 agreement, the Turkey 1959 agreement, and the Ghanaian agreements of 1966 and 1968, each of which had a grant element close to 25 per cent.

Most of the debt relief agreements have been on terms close to those of the original suppliers’ credits on which relief has been requested. The debt relief agreements not on commercial terms—i.e., those with a high grant element—tend to represent creditor responses to special situations. For example, the 1970 Indonesia agreement followed a decision to provide a long-term solution to the Sukarno-era debts; and the 1968 India agreement gave relief on relatively long-term intergovernmental loans.

Apart from softening the average terms of past borrowing, debt relief increases the free foreign exchange available for imports. Debt service obligations must be met through the transfer of foreign exchange earned through exports; but disbursements of foreign assistance (other than from debt refinancing loans) usually consist of credits available for buying a specified set of goods and so cannot be used to offset debt service payments. Debt relief, however, frees foreign exchange from servicing such obligations and thus permits a debtor country to import more, and maintain a higher level of consumption or growth than otherwise.

Table 2.Multilateral Debt Renegotiations, 1956—May 1973
Scope of Debt ReliefRepayment TermsGrant
Country and Date

of Multilateral

Agreement
Consolidation

Period
Type of Debt

Covered
Proportion of

Maturities

Consolidated
Amount

($ mn.)
Grace

Period
Amortization

Period
Moratorium

Interest Rate
Element of

Rescheduling

(10% discount rate)
ARGENTINA
May 30, 1956Balance,Suppliers Credits100%50010 years 123.8%
June 30, 1956
January 20, 19612 years

(1/1/61-12/31/62)
(a) Suppliers Credits

(principal only)

(b) Official loans

Suppliers Credits
50%2841 year5 yearsn.a.n.a.
October 26, 19622 years

(1/1/62-12/31/64)
50%1746 years6%13.2%
June 26, 19651 year(a) Suppliers Credits60%702 years5 years11.5%
(1/1/65-12/31/65)(principal only)
(b) Bilateral Official

project loans
BRAZIL
May 24, 19614½ years

(6/1/61-12/31/65)
Suppliers Credits1961—80%

1962—70%

1963—70%

1964—50%

1965—35%
4076 months5 yearsn.a.n.a.
July 1, 19642 years

(1/1/64-12/31/65)
(a) Suppliers Credits

covered by 1961

Agreement

(b) Suppliers Credits

contracted before

12/31/63, with

maturity over 6

months
70%

1964—20%

1965—25%
1852 years5 yearsn.a.n.a.
CHILE
February 24, 19652 yearsSuppliers Credits70%762 years5 years5⅞15.4%
(1/1/65-12/31/66)(Principal only)
April 19, 19721 year 2 months(a) Suppliers Credits70%2782 years6 yearsn.a.n.a.
(11/1/71-12/31/72)(b) Long-term loans
of less than 40-years maturity (excl. debt refinancing loans)
GHANA
December 9, 19662 years 7 months (6/1/66-12/31/68)Suppliers Credits80%1142 years 6 months8 years6%23.0%
October 22, 19683 years 6 months

(1/1/69-6/30/72)
Suppliers Credits

covered by 1966

Agreement
80%842 years7 years 6 months26.3%
July 11, 19702 yearsSuppliers Credits50%2210 years2 years 261.0%
(7/1/70-6/30/72)covered by 1966 and

1968 Agreements
INDONESIA
December 20, 1966

October 18, 1967

October 17, 1968
1 year 6 months

(7/1/66-12/31/67)

1 year

(1/1/68-12/31/68)

1 year

(1/1/69-12/31/69)
All public debt 4

Debt covered by 1966 Agreement

Debt covered by 1966 Agreement
100%

100%

100%
1,0333 years8 yearsn.a.n.a.
April 24, 1970Balance Outstanding 1/1/70All public debt, incl.

rescheduled contracted

before 7/1/66.
100%2,081Principal: none Interest: 15 yrs30 years2599%
INDIA
March, 5, 1968 564 yearsAll public debt 4Variable 3407n.a.n.a.n.a.49.0%
(4/1/68-3/31/72)-
December 27, 1972 61 year

(4/1/72-3/31/73)
All public debt 4Variable 3151n.a.n.a.n.a.59.1%
PAKISTAN
May 26, 19722 years 2 monthsn.a.n.a.2342 years3 yearsn.a.n.a.
(5/1/71-6/30/73)
PERU
September 27, 19681 year 6 monthsSuppliers Credits75%1461-1½ years4-4½ years9.0%
(7/1/68-12/31/69)(minimum)
November 19, 19692 yearsSuppliers Credits60%1091 year4 years8-9%4.6%
(1/1/70-12/31/71)(minimum)
TURKEY
May 11, 1959

March 27, 1965
6 years 4 months

(8/30/58-1/1/64)

(a) 3 years

(1/1/65-12/31/67)

(b) 4 years

(1/1/64-12/31/67)

(c) Variable
Suppliers Credits

Consolidated Suppliers

Credits (principal only)

European Fund Credits

(principal only)

Government loans
100%

60%

66-80%

Variable 3
443

60

70

90
none

6 years

Variable

Variable
12 years

3 years

2 years 6 months

Variable
3%

n.a.



Variable
27.4%

30.5%

Extended to 10 years in 1961.

Interest free, except that 4% interest chargeable on amounts deferred under bisque clause.

Debt relief given mainly through refinancing loans, the terms of which differ.

Debt of the public sector or guaranteed by the public sector in the borrowing country.

The India debt relief arrangements of 1968 originally were for a 3-year period with annual commitments; this procedure was extended for an additional year in June 1971.

Dates are those of a record of understanding reached between consortium members and the Government of India. Source: IBRD (May 1973)

Extended to 10 years in 1961.

Interest free, except that 4% interest chargeable on amounts deferred under bisque clause.

Debt relief given mainly through refinancing loans, the terms of which differ.

Debt of the public sector or guaranteed by the public sector in the borrowing country.

The India debt relief arrangements of 1968 originally were for a 3-year period with annual commitments; this procedure was extended for an additional year in June 1971.

Dates are those of a record of understanding reached between consortium members and the Government of India. Source: IBRD (May 1973)

The current debate

The question of whether debt relief should be considered as short-term or long-term assistance continues to be debated, and it continues to exacerbate the relationship between the developing and the developed countries of the world. The long-run approach, taken in the case of Indonesia, is unusual. However, the appropriate approach to the individual problems of other debtor countries is still undecided.

The discussion of India’s debt problem within the framework of the Aid Consortium has been independent of any immediate liquidity problem. However, the Paris Club still appears to regard an acute liquidity crisis as a prerequisite for calling a creditors meeting. The Paris Club takes the position that debt relief is a special type of external assistance to be distinguished from “foreign aid.” This is particularly true when it is a question of giving debt relief on suppliers’ credits: these were commercial transactions, and debt relief is regarded as a modification of commercial terms.

There are a number of reasons for this view. First, requests for debt relief have been most commonly made on private sector suppliers’ credits: such commercial contracts are expected to be honored, and readily available debt relief on concessional terms is thought to threaten the sanctity of other suppliers’ credits held by other creditors. Second, the creditors have been continued on concerned that the government seeking debt relief should pursue policies consistent with rapid restoration of a balance of payments equilibrium including an adequate allowance for debt service. It is felt that if the debtor knows that he must face new debt obligations again in one or two years, he has an incentive to meet his policy commitments. The creditors also fear that debtor countries would not follow prudent external debt management policies if consolidation were a normal form of development finance, and if there was some simple procedure for debtors to appeal to their creditors for relief.

The debtor countries facing debt crises have argued for the abandonment of a distinction between debt relief and aid. The short-term nature of conventional debt relief agreements has made long-range economic planning difficult. Also when debt relief is given for one to three years, a large bulge in debt service payments due arises in the following few years. Without a rapid increase in net exports, this necessitates further debt relief—which may or may not be forthcoming—and more negotiations which will tie up much of that country’s diplomatic and economic talent. Also, the policy measures required by the creditors generally focus entirely upon the stabilization of domestic demand and do not relate adequately to the country’s need to stimulate net exports and overall growth. Recognizing this problem, the Pearson Commission Report recommended that:

  • (a) Debt relief operations should avoid the need for repeated reschedulings and seek to reestablish a realistic basis for development finance.

  • (b) When it is necessary to set limits on new export credits, equal attention should be given, where there is a sound development program, to the possible need for concessional external assistance.

  • (c) Aid-giving countries should consider debt relief a legitimate form of aid and permit the use of new loans to refinance debt payments, in order to reduce the need for full-scale debt negotiations.

The question of debt relief was one of the topics of discussion of the 1972 UNCTAD III Meeting in Santiago. Unfortunately, the discussion between national representatives failed to generate an approach to the debt problem which was mutually acceptable to the developed and the developing nations. The latter (known at the meeting as “the Group of 77”), sponsored a resolution that debt relief be granted with some degree of automaticity. New loan agreements should contain a “bisque clause” providing automatic postponement of scheduled debt service payments under certain prescribed conditions. Some multilateral frameworks should be created (within UNCTAD) for examining individual countries’ debt service problems, and standards should be established for granting debt relief.

The emphasis of the Group of 77 resolution was on establishing a formal, multilateral institution for reviewing debt problems, and it was implied that the developing, or debtor, countries themselves would have a significant role in its operation. This proposal was rejected by the representatives of the creditor countries. One point they emphasized was that the Group of 77 resolution did not give proper attention to the role of adequate domestic financial policies and external debt management in avoiding a debt crisis. It was felt that creating a special institution for debt relief would be likely to invite debt crises rather than prevent them. While recognizing the need for giving debt relief, the creditor country representatives restated their view that it should be handled through an informal institutional arrangement and should be considered on a case-by-case basis. The UNCTAD discussions did not lead to any agreement on action over debt problems; the effect of the discussions was rather to polarize the views of the two groups of countries.

A need for flexibility

From the experience of past multilateral debt rescheduling arrangements, it is evident that the problem of external indebtedness requires full understanding on the part of both creditor and debtor countries of how past debt crises evolved. Debt crises following large-scale borrowing through supplier credits resulted in part from inappropriate financial and debt management policies in the borrowing country and from a failure of export credit insurance agencies to take account of impending crisis situations. The solution to this kind of debt crisis may call for various types of response, taking into account the export growth prospects of the debtor country and the likely availability of private and official capital flows from donor countries.

The debtor countries’ call for special institutional arrangements to facilitate debt relief could affect the flow of funds from developed countries. A substantial part of development funds today are available through suppliers’ credits and commercial bank medium-term loans. These private capital flows, and also official development lending, are forthcoming on the understanding that they will be repaid according to agreed schedules. Assuming that flows will continue largely on loan terms and that, from time to time, countries may run into debt service difficulties, it seems safe to conclude that an appropriate response can only be on a case-by-case basis. The debate on debt relief should not be on whether it is long-run or short-run assistance; the search should rather be for flexibility in evaluating requests for debt relief.

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